The First Word: The right to wage war carries a financial duty

The government must cover the economic losses of the Galilee residents - immediately

By JONATHAN LIPOW

July 27, 2006 12:26

4 minute read.

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(photo credit: Juha)

It could take the IDF a long time - perhaps several more weeks or even a month - to weaken Hizbullah sufficiently so that an international force and the Lebanese army have a realistic chance of disarming the terrorists. In the meantime, people who live in Galilee and businesses that operate in the north of the country will suffer severe economic hardship while the government's budget expense for the prosecution of the war will mount.
How should the government meet the conflict's economic challenges? First of all, there is a question of compensation for the war's victims. So far, the government has been inexplicably hesitant to authorize full compensation for people who have lost their livelihoods as a result of the fighting.
Economic theory is quite unambiguous regarding this point. Every citizen should be fully insured against damage stemming from external security threats.
Wars hurt us all, but the damage is not spread evenly. Some people are barely harmed while others lose everything they own - or even their lives. What determines who lives and who dies, or who gains or loses? More than anything, this is determined by random luck rather than choice. As they say in finance, "sometimes you are the windshield and sometimes you are the bug."
People should be insured against this possibility of bad luck. Why? Because it makes us all better off.
Remember: You cannot know in advance if you will be lucky or unlucky. Say that one person in 10 will face real economic losses as a result of the fighting - say $100,000 in losses. We do not know if that person will be us. Which would you prefer: (1) taking a one-in-a-hundred chance of losing $100,000; or (2) losing $1,000 for sure?
Most responsible people would choose the latter option. That means they would pay for insurance that would protect them from this type of risk. Hence, we are better off if we can insure ourselves against the risk of taking financial losses as a result of warfare.
But why does the government have to supply this insurance? Why can't private insurers do the job?
The answer is simple. If a private company insures Israelis against war risks, then a strange reality is created. It is Israel, not insurers, that chooses to engage in war, but it is the insurers that would have to pay the bill.
Not surprisingly, private companies don't feel comfortable with such an arrangement, and will not insure a country or its citizens against risks related to the belligerent acts, whether justified or not, of that same country.
The bottom line? Countries cannot forfeit the right to wage war. Hence, they cannot avoid taking financial responsibility for the outcome. Individuals, moreover, do not get to choose whether their country goes to war; hence the government certainly can, and is obligated to, insure them. The government should cover the economic losses of the Galilee residents - immediately.
THAT, HOWEVER, raises another problem. How should the government finance the compensation of the war's victims? For that matter, how should it finance the very expensive "bunker buster" bombs that we seem to drop by the dozen in Lebanon?
Once again, economic theory provides clear guidance on this issue, and that guidance is - once again - at odds with government policy so far. When faced with a sudden and sharp spike in expenditure, the correct action is always to finance the expense via budget deficits. It never makes sense to temporarily cut other spending or raise taxes.
The reasoning behind this is entirely straightforward. People are best off when their consumption of both public and private goods is "smooth." That is to say, they are happiest when they consume roughly the same amount each year.
This means that the "least social cost" way to finance the war is to cut spending modestly, raise taxes a little bit, and borrow a lot of money that we will pay back over the long run by keeping spending modestly lower and taxes a little bit higher than we otherwise would have. This is obviously superior to any program of crash spending cuts or emergency tax hikes.
Of course, the Finance Ministry will predictably issue dire warnings that allowing the fiscal deficit to rise will undermine Israel's position in global financial markets, but enough is enough.
Few of the people at Finance have ever actually participated in global financial markets, and their strongly held belief in the efficacy of markets, combined with their equally strong belief that international investors are a bunch of economically illiterate lunatics who panic whenever a country implements an entirely logical "textbook" economic policy, makes little sense.
One last painful issue regarding the war and decision-making at the Finance Ministry has to be addressed. Due to the ministry's almost single-minded focus on fiscal deficits, it bears considerable responsibility for the poor readiness of the IDF in general, and the reserve forces in particular.
Year after year, Finance has insisted on sharp unplanned last-minute reductions in the defense budget in order to meet self-imposed deficit targets. This has made a shambles of long-term defense planning.
The Defense Ministry has understandably responded to these sudden budget cuts by reducing what, at the last moment, can be cut rather than what, in the long run, should be cut. The predictable result? Reserve units have barely trained for the past three years.
This is severely handicapping our war effort, and may have contributed to the poor tactical outcome in the incident that got this war going. Perhaps the Finance Ministry should reconsider its pursuit of policies that are penny wise and pound foolish.
The writer, currently on sabbatical, is a visiting associate professor in economics at Berea College in Kentucky. He also serves as the portfolio manager for the Forum International Equity Fund.

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